Sunday, January 06, 2013

A Three-way Framework for Classifying Business Cycle Theories?

My colleague in this research and I were considering that we had two major dimensions along which to classify business cycle theories: exogenous versus endogenous, and truly cyclical versus pseudo-cyclical.


An exogenous theory would be one that attributed cycles to, say, sunspots effecting agricultural output. An endogenous one would attribute, perhaps, the pessimism of the downturn to an expected reaction to the over-optimism of the boom.

A truly cyclical theory contains an explanation of why boom turns into bust which turns into boom: it explains why these states tend to repeat. A pseudo-cyclical theory (like real business cycle theory) explains the appearance of a cycle as being the result of random disturbances plus, perhaps, hysteresis.

But I think we need a third dimension as well: real versus monetary. At first I thought this could be subsumed under exogenous versus endogenous, where real factors are exogenous and monetary ones are endogenous. But now I see that is incorrect: a theory could hold that real, endogenous factors drive the cycle (for instance, the exhaustion of investment opportunities leading to a downturn, per Schumpeter or Cowen), while a theory could also regard monetary policy as exogenous (the central bank simply alters the quantity of money available with no causation coming from within the model).

Please excuse me if I am stating the obvious to you: I am learning!

1 comment:

  1. I agree that monetary v real makes sense.

    Some theories (example: an increase in the demand for money combined with sticky prices will cause a bust) would not be viable without assumptions that prices and/or the money supply are not perfectly flexible. These theories would be monetary in nature.

    Others theories (example: lack of new technology leads to lack of investment opportunities) would be viable even with the assumption of flexible prices and money and so could be categorized as real in nature.

    On endogenous/exogenous and true/pseudo theories: I haven't thought this through fully but I can see a case to say that any cycle theory that is driven by exogenous factors (such as change in technology or demand for money) are not true cycle theories (unless the exogenous factor is itself cyclical - in which case it would be part of the theory and therefore not really exogenous).


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